Does a non-deductible IRA make sense?
Assume 1) our income is too high for a deductible IRA, 2) past capital gains in the account would make it too expensive to convert to Roth, and 3) the tax rate for withdrawal is expected to be much higher than capital gain tax rates. Does putting money in a tax deferred IRA now make sense compared to putting it (index ETFs) in a non-retirement account in a buy-and-hold mode to be liquidated after 10-15 years?
It appears there’s no immediate benefit because it’s not tax deductible and the annual distributions are likely to be a small disadvantage in the taxable account. However the difference between capital gain tax rates and regular income rates ought to be a huge advantage when sizeable withdrawals begin to be made.
Is there some flaw in my analysis that should make me reconsider funding non-deductible IRAs?
Permalink Submitted by Alan - IRA critic on Fri, 2014-07-04 03:02
The MAGI threshold for regular Roth contributions is considerably higher than the threshold to deduct a TIRA contribution. If you qualify for regular Roth contributions, that is always better than a non deductible TIRA contribution. But if MAGI is too high for a Roth contribution also, there may or may not be an advantage to the non deductible TIRA contributions vs. taxable investing for cap gains. If you have no pre tax amounts in non Roth IRAs you can make a contribution and convert it right away tax free. Or if you do have pre tax amounts in a TIRA, you can often roll them into an employer plan and then convert the remaining basis tax free as well. For some people it pays to convert even if they have to pay taxes and if you do not make the non deductible contributions when you can you may not have anything to convert. The only other advantage of a non deductible TIRA contribution is that it provides tax deferral similar to a tax deferred annuity. In the taxable account there is only tax deferral on gains if you never sell (or step up at death), but most stocks also kick out annual dividends that are not tax deferred. In other cases the taxable investing may be equal or better.